In 2008, the housing market brought down the global economy. Could this happen again? And how long? Although I don’t want to play the role of Mr. Doom, in this article I would like to highlight some notable developments that may prove be extremely important for the stock market. Personally, I see the beginning of a major downturn in the housing market, as: mortgage rates have risen in recent months, home sales are plunging, housing inventories are piling up, and home price appreciation houses slows down. So far, stock market investors have largely ignored the cracks in the housing market. But if the situation worsens further, the dangers posed by a housing market crash will be too pressing to ignore.
Over the past decade, buoyed by historically low mortgage rates and quantitative easing, U.S. home prices have appreciated at a pace that rivals the pre-2008 rise. And the sentiment was bullish , otherwise sparkling. It was only recently that Redfin agent Shauna Pendleton commented on the unsustainable expectations of homebuyers/fins:
They priced (their house sales) too high because their neighbor’s house sold for an exorbitant price a few months ago, and expected to receive several offers the first weekend because they had heard stories about it.
4 danger signs
But the monetary policy tailwind has now turned, with mortgage rates rising rapidly and quantitative easing turning into quantitative tightening. And market sentiment has changed accordingly. I would like to present four key metrics and charts to anchor my thesis.
Increase in mortgage rate
First, and perhaps most importantly, soaring mortgage rates, which are putting pressure on the availability and affordability of financing for the purchase of a home. The average 30-year fixed rate mortgage rate in the United States has more than doubled since the start of 2021, from 2.65% to 5.7% in August 2022.
Slowdown in year-over-year price appreciation
Second, and surely also as a function of rising mortgage rates, house price appreciation has slowed markedly.
Admittedly, house prices have not yet started to show negative growth. But that could simply be a function of the illiquid nature of the real estate asset class, where a downturn first results in an accumulation of inventory due to price stickiness, followed by an aggressive revaluation of that inventory.
But in some select markets, prices are already starting to fall, according to data from Zillow.
Home sales plummet
Third, home sales are falling rapidly. Notably, the number of home sales nationwide fell 19% year-over-year in July. New home sales appear to be falling off a cliff.
On August 23, Toll Brothers, Inc. (TOL), America’s largest luxury homemaker, announced its June quarter results. It reported a slump in quarterly orders of 60% from a year earlier. Additionally, the company also cut its sales outlook for the year and named rising interest rates and slowing housing demand as key challenges. Toll Brother CEO Douglas Yearly commented:
we have seen a significant drop in demand as the combined impact of sharply rising mortgage rates, rising house prices, stock market volatility and macroeconomic uncertainty has caused many potential buyers to withdraw
Fourth, home inventory builds up.
Lawrence Yun, chief economist at NAR, said in a statement:
We are seeing a housing recession in terms of declining home sales and home construction.
The importance of the housing market to the health of the economy, and therefore to the stock market, cannot be underestimated. A stable housing market supports financial stability through mortgages, consumer confidence through wealth effects, and economic activity through various buildings and constructions.
As the US housing market begins to show very significant danger signals, as discussed in this article, I would advise investors to be very careful with their stock market exposure and capital allocation. Personally, and also due to broader macroeconomic weakness, I would advise investors to remain underweight cyclical sectors such as financials, materials and construction and overweight strong technology companies with high margins, resilient balance sheets and relatively low risk growth…which is tied to secular trends such as digitalization and decarbonization.